It turns out that war is bad for business. But maybe not as bad as feared.
Apple Inc. and Qualcomm Inc. are locked in a nasty legal fight over how the chip designer charges for its products and proprietary technology. And now Apple is plotting designs for next year's iPhone and iPad models that don't use Qualcomm components. It's Apple's version of an ultimate insult to Qualcomm, its onetime key supplier turned mortal enemy.
Apple hasn't made a final decision about designs or parts for the future iPhones and iPads, Bloomberg News reported. If Apple stops using Qualcomm parts, of course, it's not good news for a company that has been battered this year. Qualcomm shares fell about 7 percent in early trading Tuesday after the Wall Street Journal reported about Apple's potential plan to drop Qualcomm chips.
But Apple plotting to ax Qualcomm also isn't much more of a disaster in what has already been Qualcomm's year of hell.
That is because many stock analysts have already expected Qualcomm's revenue from Apple, which has generated about a quarter of Qualcomm's $7 billion to $8 billion in annual revenue from technology licensing, will shrink to near zero next year. That expectation is essentially already reflected in the 16 percent decline in Qualcomm's stock price this year.
And no matter whether Apple uses Qualcomm chips in its future phones and tablets, in theory Apple will still need to pay the Qualcomm tax. Those are royalty fees Qualcomm charges for devices that uses its technology, which is intimately involved every time smartphones send and receive cellular internet data. Of course, Apple's lawsuit against Qualcomm is essentially a bid to end the Qualcomm tax as it has existed.
Apple is disputing how Qualcomm charges a royalty based on the price of phones rather than the cost of the relevant smartphone component. Apple partners such as Foxconn, which are the ones who pay licensing fees to Qualcomm, have withheld payments while the companies battle it out in court. Even when Apple paid the tax through its suppliers, the revenue was a drag on Qualcomm's margins, according to Mizuho Securities, because Apple has used its muscle to negotiate a lower royalty for Qualcomm's technology.
Qualcomm naturally doesn't want to lose Apple as a customer. But even before the legal fight, it has been clear that Apple represented Qualcomm's past glories, not its future. The company that rose to power on the back of the worldwide mania for smartphones, which provide the bulk of Qualcomm's revenue, has to look elsewhere for growth. Globally, the number of smartphones isn't increasing much. Research firm IDC expects sales of smartphones to increase by a compound annual growth rate of just 3.3 percent through 2021. By contrast, as recently as 2014 smartphone sales surged 28 percent.
The writing has been on the wall for some time, and it explains the reordering of the chip world to favor companies that are betting on what comes after the smartphone. Once relatively small, Nvidia Corp. has surged past Qualcomm in market value after investors decided Nvidia's chips are ideally suited for growth markets including artificial intelligence and driverless cars. Ditto for Micron Technology Inc. and other companies that make memory chips required for massive data-crunching duties including artificial intelligence. Shares of Micron and Nvidia have doubled this year.
The hunt for fresh markets is also why Qualcomm struck its biggest deal in history to buy NXP Semiconductors last year for $47 billion. That big splurge was a sign of how Qualcomm is trying to reduce its reliance on Apple and other smartphone companies and diversify into cars as they become rolling computers. The deal isn't closed yet as regulators take a look at the combination, and some Qualcomm watchers doubt it will be finalized this year.
The fight with Apple is without question an existential risk for Qualcomm's current business. But no matter how it pans out, Apple isn't making Qualcomm's life any tougher. The company was already in an epic slog for the future.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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